Paddy Dowdall: The building blocks of pension fund investment in housing

Housing is a front page topic and pension funds have a role to play. Paddy Dowdall describes how Greater Manchester Pension Fund came to invest in the city’s housing sector.

Greater Manchester Pension Fund (GMPF) believes that investing in housing for sale and rent in its local area is consistent with its key aim of maximising long-term investment returns, whilst not exceeding an acceptable level of risk.

The fund has had a consistent approach to investment for over 25 years that is underpinned by its core belief statement and demonstrated by investment returns that are among the highest for LGPS funds over 25 years.

The key aspects of this are a belief in a long-term approach, and in having appropriate governance arrangements which allow the internal management of some assets with proper accountability to the management panel.

Other core beliefs are that diversification is a key strategy to reduce volatility of the overall fund return, and that alternative assets such as corporate bonds, private equity and property offer additional risk premia such as illiquidity, for which the fund is adequately rewarded.

GMPF has also had, for many years, a policy that it is a positive benefit for the fund to invest in the local area subject to achieving commercial returns. Commercial returns are linked to the required returns for the fund assumed within the actuarial valuation and consequent investment strategy.

Housing

The fund’s investment strategy and individual decisions are made with reference to these core beliefs. When considering the opportunity of investing in housing the fund first had to establish whether there was a need for investment in housing? This is a key question as it would also determine whether the investment would have a positive impact on the local economy.

Also, the greater the need for housing the more likely it would be that the investment returns would be successful. A key decision was whether or not to target the rented sector or owner occupier sector.

Nationally, the scale of house building is well below government targets and promoting the building of homes is becoming a political priority.

Issues preventing homes being built are well documented: the uncertain economic climate; the ability of house builders to fund developments due to a shortage of capital; affordability from the home owner or tenant’s perspective; availability of mortgages to first time buyers or those with inadequate equity.

Greater Manchester had seen a dramatic decrease in housing completions since the peak of the market in 2007/08. A report to the Greater Manchester Combined Authority in 2016 identified that 217,000 houses would be needed by 2035 to meet demand from forecast demographic changes. The current rate for completion is around 6,000 a year. The trend is upwards but requires further investment.

Investment vehicle

Having established that investment in homes was needed in the area the second stage was to establish an appropriate investment vehicle. The fund has always worked closely with its local authority employers in the local investment strategy and the first opportunity arose with Manchester City Council (MCC).

MCC approached the fund to ascertain whether GMPF would be interested in investing in the development of new build residential accommodation which would ultimately be let at market rent.

In working up the model MCC agreed to identify sites within their ownership and control which are capable of supporting residential development and may also deliver regeneration benefits.

The collaborative approach and the transfer of council owned sites are key to underpinning the returns to the pension fund and focusing the regeneration benefits of the local area.

As a consequence of the MCC’s approach, GMPF agreed to work collaboratively with the council in order to explore the opportunity to design a new residential development model which can initially be applied to city council-owned sites. The objective was to deliver a mixture of homes available to let at market rent and eventually for sale at market value.

A new joint venture company, Matrix Homes, was established between GMPF and Manchester City Council. This pioneering approach was a first-of-its-kind partnership. GMPF agreed to invest over £25m to enable 240 homes to be built on four sites owned by city council, and also a site owned by the Homes and Community Agency.

There was a collaborative approach to ensure that the business and financial model met the needs of both parties.

The key elements for the pension fund investment is that it is predominantly of a fixed income nature and that a significant proportion of the drawn down investment is re-paid early, this necessitates a mix of sale of properties and rented properties, approximately 50% of each.

The building contractor appointed was Wates Living Space. The tenure mix across the five Manchester sites was developed to ensure each location fits in to the property requirement for the local area.

To control risk, for rented homes, there is a long-term lease to a head tenant who manages the properties. This means that the fund is not exposed to void and bad debt risks or other operational risks. This head tenant is Places for People and the firm Plumlife are responsible for marketing the properties for sale.

There is a sale at the end of the lease to the head tenant which provides final cash-flow and return on equity to the council and pension fund. This is the only part of investment return dependent upon property prices.

The financial model was robustly tested and has proven to be conservative. Following a successful construction phase the sales and rental proceeds have exceeded expectations.

We are in the early stages of Matrix 2 which is envisaged to build over 300 homes. It is also proposed to roll out the model to other local authority-owned sites within Greater Manchester. We are actively promoting the opportunity to other authorities both with Greater Manchester and with our Northern Pool partners.

There is no presumption at this stage to deliver social housing through this model, but it could provide an option dependent upon the nature of future sites and the subsequent financial viability.

In addition to the Matrix schemes the fund has made loans to developers alongside the GM Housing Investment Fund an example would be a large development at Owen Street in Manchester, where 1,500 homes are being built.

These fixed income investments provide a stable yield secured by a solid collateral base. GMPF is, at various stages in the process, committed to providing financing for the construction of 4000 new homes and the Northern Pool is targeting 10,000 over the next 3 years.

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